F—Tax Treatment Of
Premium Payments
As a general rule, premiums for life insurance are not
deductible for income tax purposes.
General Rule
Premiums paid by the insured for personal life insurance
policies are considered personal expenses and therefore are not deductible from
gross income [I.R.C. §262; James Kutz, 5 B.T.A. 239].
It is immaterial whether the insurance is government life insurance or
commercial life insurance. This same rule applies to an employee`s
contribution to group life insurance [Austin T. Flett,
19 T.C.M. 825].
Business Life Insurance
Generally, a corporation cannot take a deduction for premiums
paid if it is either directly or indirectly a beneficiary under the policy.
[I.R.C. §264(a)(1)]. Thus, if a
corporation purchases a life insurance policy covering the life of any officer
or employee, or of any person financially interested in any trade or business
carried on by the taxpayer it will typically be both owner and beneficiary of
the policy. The deduction is also prohibited where the corporation only
has some beneficial interest in the policy (but not as a named
beneficiary). For example, a corporation may have the right to change the
beneficiary, make loans or surrender the policy for cash. In these cases,
no deduction is allowed.
However, corporations often purchase life insurance for their
employees where the proceeds are payable to the employee`s
estate or named beneficiary. In this case, because the corporation has no
ownership rights or beneficial interest in the policy, it can deduct the
premiums as a business deduction under Code §162 for ordinary and necessary
expenses incurred in carrying on a trade or business.
Premiums Paid By Debtor To
Secure Loan
A taxpayer who takes out a policy of life insurance in favor
of a creditor in order to procure a loan and as security therefor
is not entitled to deduct the premiums paid on such policy [Rev. Rul. 68-5, 1968-1 C.B. 99]. Since the death proceeds will
be used to discharge the debtor`s obligations, the
insured is the indirect beneficiary [I.R.C., §264(a)(1);
Rieck v. Heiner, 25 F.2d
453, cert. denied 277 U.S. 608; Jefferson v. Helvering,
121 F.2d 16; Ragan v. Comm`r, 40 T.C.M. 13 (1980)].
If the debt is a business debt, a deduction is also not allowable as a business
expense or otherwise [Richard M. Glassner, 43 T.C.
713, aff`d 360 F.2d 33 (on another issue)].
Such premiums are nondeductible even where the insured debtor
was required to purchase and maintain the policy in order to obtain the loan
[Jefferson v. Helvering, 121 F.2d 16; Klein v. Comm`r, 84 F.2d 310; Joseph J. O`Donohue,
33 T.C. 698; Roy H. King, 22 T.C.M. 1344].
Likewise, where the borrower pledges existing insurance upon
his life as collateral security for a loan, the premiums are not deductible.
[Warren Leslie, Sr., 6 T.C. 488].
If a creditor voluntarily purchases, owns and is the
beneficiary of insurance on a debtor`s life, premiums
paid by the creditor are not deductible for income tax purposes [I.R.C. §§262,
264(a)(1)], and the proceeds are exempt [I.R.C.
§101(a)(1); Durr Drug Co. v. U.S., 99 F.2d 757].
If a debtor assigns his insurance policy to his creditor as
collateral, and the creditor pays premiums on it, a special problem arises.
Whether a creditor can take an income tax deduction for the amount of premiums
paid depends upon whether the loan is a business or personal one.
Business Transaction
Generally, the debt must be worthless or uncollectible before
the creditor can deduct the premiums paid, regardless of the creditor`s ability to recover the premiums from the cash
surrender value [Comm`r v. Charleston Nat`l Bank, 213 F.2d 45 (CA-4, 1954); Dominion Nat`l Bank v. Comm`r, supra].
However, the IRS position, which differs somewhat from the courts` position
allows the creditor to deduct the premium payments when there is no right of
reimbursement from the debtor-either under the terms of the loan, the
assignment, or state law-and the right to be reimbursed from policy proceeds is
worthless, because the debt is greater than the cash surrender value of the
policy [Rev. Rul. 75-46, supra].
However, the courts have held that a creditor can take a
deduction as an ordinary and necessary business expense incident to the
protection of the collateral [First Nat`l Bank &
Trust Co. of Tulsa v. Jones, 143 F.2d 652 (CA-10, 1944); Dominion Nat`l Bank v. Comm`r, 26 B.T.A.
421 (1932), Lock, Moore, & Co. Ltd. v. Comm`r, 7
B.T.A. 1008 (1927); Rev. Rul. 75-46, 1975-1 C.B. 55].
Non-Business Transaction
If a creditor pays premiums on a policy securing a
non-business debt, then premium payments are not deductible as ordinary and
necessary business expenses under Code §162. According to the courts, because
such expenses are not incurred to produce or collect income, they are
considered to be a capital investment. The creditor cannot deduct
the premium payments unless he has a worthless right to reimbursement.
Premiums Paid As Charitable Gifts
An insured can take a charitable deduction for premiums paid
on a policy owned by a charitable organization, subject to the annual
limitations on the amount of the charitable deduction [I.R.C. §170; Eppa Hunton IV, 1 T.C. 821].
Where an insured irrevocably assigns a new policy to charity,
and pays the initial premium the same day, the premium is deductible [Rev. Rul. 58-372, 1958-2 C.B. 99].
Note that the manner in which the premium payments are made
could affect the applicable limitation on deductibility. The income tax
deduction for contributions to a qualified public charity is generally limited
to 50 percent of the taxpayer`s AGI, but in the case
of contributions which are not to the charity but merely for the use of the
charity, the lower 30 percent limit is applicable. If the donor/taxpayer
pays the insurance premiums directly to the insurance company, this is not
considered a gift to the charity which owns the policy, but rather a gift for
the use of the charity. Thus, the 30 percent limitation is applicable.
On the other hand, if the funds for the payment of premiums are paid by the
donor to the charity, and the charity makes the payment to the insurance
company, this would be a gift to the charity, and the higher 50 percent
limitation would apply. Thus, attention to this substantively meaningless
procedural distinction could make a difference in the case of a taxpayer whose
overall charitable contributions are sufficiently high as to be affected by
these deduction limitations.